Customised benchmarks, absolute return strategies and long-term mandates are all being considered by the PGGM executive team as it implements the new PFZW investment framework. Amanda White spoke to Ruulke Bagijn chief investment officer of private markets and Marcel Jeucken, managing director responsible investment at PGGM about what it really means to be a long-term investor.

The €167 billion ($228 billion) Dutch pension fund manager, PGGM, is working under a new investment framework which is the result of an 18-month soul-searching review by its client PFZW, under a project called “The White Sheet of Paper”.

The investment framework has been adopted by the board and now the focus has shifted to implementing the investment framework.

It’s a work in progress, and involves both incremental and transformational change. Ruulke Bagijn chief investment officer of private markets at PGGM and Marcel Jeucken, managing director responsible investment at PGGM both sit on a working committee to determine the best way forward.

“Such a review makes you focus on what really matters,” Bagijn says.

She says at the core of the strategy is sustainability, and she identifies with the Michael Porter concept of “shared value”.

“The benefits we pay are worth more in a world worth living in,” Bagijn says. “We also can’t produce returns in a system that doesn’t work, so the sustainability of the financial system is a core part of what we look at as a long-term investor.”

PGGM’s focus will be taking on a larger role in the viability and sustainability of the world. It’s no small ambition, but it’s one that many large institutional asset owners are addressing as the debate over short-termism continues.

“Long term investing for us is providing a valuable future, providing a pension in a sustainable world. It’s working for the current generation but not at the expense of future generations. A sustainable and viable world includes saving a good pension and contributing to the economic and financial environment in which we operate and live.”

It focuses on a stable financial sector, human rights and good corporate governance with emerging investment themes as part of this including climate change, water, food security and health.

She says PGGM will intensify its efforts in focusing on long-term horizons, which leads its policy choices, including asset allocation.

In implementation terms this means better benchmarks, alternative strategies in public markets and more focused portfolios.

“As a long term investor we look at asset allocation and now wand to design a dynamic element to that. In terms of sustainability we will look at benchmarks, investing more in The Netherlands, agency issues and remuneration. We’ll look at our own behaviour and the behaviour of others, and want to continue to have a pioneering role in promoting a sustainable financial system,” she says.

“We think there needs to be courage from pension funds to create their own benchmarks and worry less about peer risk,” Bagijn says.

Customised index

PGGM has developed an index in house, which measures the 2800 companies in the FTSE All World Index for their environmental and social policy and good governance.

The index re-ranks the companies based on these criteria, which also include a minimum threshold. As a consequence of this, about 200 companies that don’t make it into the index have been sold by PGGM, which amounts to about 1 per cent of the portfolio.

PGGM has just completed the second year managing passively to this ESG customised benchmark, which accounts for about 90 per cent of its equities exposure, or about €44 billion in market-cap and smart beta strategies.

Marcel Jeucken, managing director of responsible investment at PGGM says the benchmark is not an exclusion strategy, rather it is about relative performance.

“It’s like an active benchmark, we don’t want to blindly follow an index. This ranks the relative performance of companies, and we think the worst companies are indicators of many things including management,” he says.

Jeucken chairs an internal working group that looks at many implementation issues in the context of the overall focus on sustainability, including benchmarks.

“We are looking at a number of areas and the impact they have. Benchmarks might lead to short termism and herding behaviour by passive and active managers. The benchmark provider actually has more impact on the stock than capital providers.”

“We try to figure out what we can do and what the impact will be. One option might be to not have benchmarks, rather have an absolute return target. We are investigating all options but the solution has to be workable.”

Jeucken says PGGM is also looking at long-term mandates and the impact and role of remuneration on short-termism.

“We have started the journey, looking at our role in financial markets, our behaviour, how we act and the measures we use,” he says. “Through the White Sheet of Paper Project we are focused on going back to asset ownership as the driver of what happens in financial markets – this includes who is employed, how benchmarks are set, the view of alignment and the view of incentive structures. It’s a big agenda, with difficult questions, and we’re not sure where it will lead us.”

Jaap van Dam, managing director of strategy at PGGM will contribute an article on the White Sheet of Paper project next month

Large pension funds might be invested on a truly global basis but their operating models are rarely global structures. Towers Watson argues that asset owners can benefit from a business model that can deliver organisational performance, manages talent and aligns with core missions from multiple operating locations.

Over the last decade, large pension funds and sovereign wealth funds have grown significantly and now dominate the investment industry both by size and influence. Typically, the source of their funds is locally derived from pension obligations or national assets.

But the destination of their funds is completely global in line with the range of investment opportunities becoming highly global and diverse. This has been seen in public markets and in particular alternatives and private markets.

The conclusion is clear. The asset owners must think deeply about how they operate in this global context – now more than ever before. And we suggest that to deserve the title of being a ‘truly global fund’, the asset owner must walk the talk with an effective multi-location global operating model.

The opportunity

Global corporates have been working with this globalisation dynamic for decades and have developed global operating models in response.

These models are ones that large asset owners could learn from and adapt to give them the best chance of competing for and capturing the returns they need. But what is an effective global operating model?

Simply put, this is a business model that can deliver organisational performance from multiple operating locations; a model that manages talent successfully globally; and a model that aligns with the organisation’s context, mission and culture.

In the highly competitive investment market place, research has shown that operating from multiple locations can provide a competitive edge and add substantial value.

This is especially true for asset owners in light of the successful trend towards bolstering internal teams with talent, particularly in the problematic areas of private markets. The advent of advanced operations and technology infrastructure allows an unprecedented level of global integration to occur.

However, a fund operating in multiple locations is likely to face a number of difficult challenges. We cite the principal issue as that of aligning culture, combining the best of the local and global ethos; but the issues extend into the decisions matrices used and how efficiently political capital is allocated; the effectiveness of oversight whenever the activities to be assessed are not local; and the impacts of trust and fairness which generally work best with close proximity.

Goals

In order to address these challenges funds will need a well-designed operating structure with clearly articulated core values, beliefs and norms specifically developed to support diverse global jurisdictions.

An interesting example of this is a fund tied to one region where its mission and obligation is to support that region for long-term social and economic provision. Were it to contemplate opening offices outside its region in large financial centres, its leadership would need to understand to what extent cultural values from their region could be transferred internationally and to what extent any dilution could be tolerated.

Another scenario is where an organisation’s central DNA is deeply wedded to risk management.  Were they to contemplate the move to a global operating model, this priority would have to receive the same attention everywhere. Otherwise one wrong deal at a local level as a result of poor engagement with head office would risk serious reputational damage.

While values and culture are soft and intangible, organisational design, roles, responsibilities and processes are not. Asset owners increasingly see the merits of enterprise-wide risk frameworks.

These frameworks are designed to define policies and procedures to mitigate risk from a wide and holistic perspective – investment, operational and reputational risks are covered. They are designed to accommodate the requirements of the regional regulator too.

Such frameworks also make managing people across geographic boundaries a little easier. For example, through standardised HR policies, talented staff can be moved around the globe to enhance the individual’s personal capability with the added benefit at a global level of the cross fertilisation of ideas and thinking.

Where to start?

There is no one-size-fits-all approach and an asset owner’s operating model should reflect its own comparative advantages, priorities and culture.

For organisations wanting to establish an overseas presence, setting up a representative office has usually been the first step to act as an outpost for extending the brand presence into non-domestic markets.

These can be useful for building and enhancing networks and to facilitate face-to-face interaction and whose value should not be underestimated2.  While setting up a representative office is a relatively low-cost approach and is unlikely to contradict the culture or identity of the core organisation, a typically constrained scope is likely to limit its ability to deliver significantly improved returns.

At the other end of the scale, fully fledged satellite offices are most effective at replicating the core organisation with the advantage of being semi-autonomous and providing an independent source of return.

This is premised on the satellite office being given the fullest remit to perform. However this is a costly option, with significant infrastructure and talent management demands and may run the risk of compromising the identity and culture of the original organisation. In extremis, a satellite office could become a source of unwanted competition and dilute the benefits usually associated with having a global presence.

Given the challenges at the edges of this spectrum, a blend that has the best of both approaches, may appeal.

These would include having a well-defined and documented split between home and satellite responsibilities and sufficient organisational flexibility to allow tailoring that plays to local strengths. For example different functions – such as research, deal origination, portfolio management, or direct investing – could be emphasised in certain locations depending on where it makes sense geographically.

In addition, individual asset classes – such as private markets, real assets, and hedge funds – could be prioritised in certain offices.  So while specialised, focused and competitive overseas offices may be appealing, they come with onerous governance requirements. And one can also challenge from the alignment of interests and the avoidance of duplicating efforts and resources point of view.

Once the decision is made on which approach to take when developing an overseas presence, the discussion will naturally shift towards implementation. This can be particularly difficult – in terms of costs, resources and time – if the chosen route is to establish a new office with a broad remit and significant autonomy. While speed may be attractive in the short term, the challenges around culture, alignment and monitoring could persist.

While there are a number of approaches, completing a spinout or strategically acquiring an external asset management business can offer a potential quick solution. These have been explored recently by some asset owners. One example is that of ABP with New Holland Capital.

So what is the best option when choosing a global operating model? In our view the least risky and easiest to implement approach would be to start with a representative office, review its effectiveness and if successful expand the scope of the operation while exploring a secondary location.

This method, if successful can be used as a blueprint for the establishment of a more autonomous satellite office.

The surprising mantra of success for asset owners is centred on how well they recognise their competitive edge and make sure strategy is congruent with this.

Choosing the most appropriate model for global expansion that aligns with the fund’s governance capabilities is critical; and so is implementing organisational design and an operating structure that gives it a sustainable competitive advantage.

Tej Dosanjh is a senior consultant in Investment Organisational Change at Towers Watson 

 

According to Malcolm Gladwell’s Outliers, at least 10,000 hours of practice is needed to be a success at your chosen profession. This means that a fund manager will hit their strides around age 40. But the London Business School is giving its students a leg up in that quest to find success. They have real-life stockpicking responsibilities as part of the student-run investment fund.

Ever wondered where the next generation of funds managers will come from? Well the London Business School is helping to nurture this next breed of money managers.

The first European school to have a student-run investment fund, it cultivates an environment of learning by doing. Students are taught to think like funds managers and three times a year there is a competition giving students the chance to pick the fund’s next stock.

The winner doesn’t just get the glory of beating their fellow students, but the honour of having real money allocated from the Student Investment Fund.

On Thursday June 5 the Summer Stock Picking Competition took place and the stockpicking finalists, students from the Masters in Finance and Executive MBA programs, were ready to present.

Each had five minutes to sell their best idea to the three-person judging panel of Dan Brocklebank director at Orbis, Jon Guiness an equity analyst from Fidelity Worldwide, Konstantin Leidman and investment manager from Schroders, (all three LBS recruiters, the latter two LBS alumni).

The Student Investment Fund was created in 2003, with LBS alumni Clint Coghill and James Lyle the first benefactors donating $100,000 over five years. The first stocks were Valero Energy and DFS Furniture, with Fimalac added to the fund in March 2004 after the first stock picking competition.

Emeritus professor, Elroy Dimson, who taught the school’s first Topics in Asset Management in February 2004, was integral in setting up the fund more than 10 years ago. Although he now has a role at Cambridge Judge Business School, he remains involved today.

“The aim of the fund is to help students understand security analysis and portfolio management,” Dimson says. “A secondary goal is to eventually provide scholarships.”

The fund has assets of around £400,000 and when it reaches £1 million it may start making distributions for scholarship purposes.

It is a long-only fund with a long-term horizon emphasising bottom-up portfolio construction and a fundamentally-driven research process. About 40 per cent is invested passively in the MSCI and the remainder is active equities.

The rules for the stockpicking competition are simple. Students present their best ideas with the only limitation that the stock has to be investable. There is no minimum market cap and the universe is global.

More broadly the fund is currently prohibited from investing in bonds, options, private placements, short sales, margin transactions, financial futures, and commodities.

Eddie Ramsden, who teaches a finance class in value investing, says “remarkably” the fund has outperformed.

“This is a totally student-led fund and it has outperformed. It’s outperformed by 9 per cent over the time frame,” he says.

Ramsden’s course is also instrumental in helping students to “think” like funds managers. They are asked to take the perspective of an investment fund manager who has to make real-time buy, sell and portfolio sizing decisions based upon their analyses and changes in both fundamentals and market prices.

“There is not usually the same level of familiarity with stockpicking at other schools,” he says. “We teach the basic concepts of what to look for in stockpicking. In the stockpicking competition students have the chance to express an idea in a concise way and there is a huge value in that. It’s about saying what the market view is and why your consensus differs.”

 

The competition

The 2014 Summer Stock Pitch Competition is run by the LBS Investment Management Club, whose catchcry is “walk on the buy side”, and the winner will become a member of the investment committee.

There are very different styles in the finalists’ presentations and the judges are determined to focus on the quality of the ideas and not the presentations.

There are about 30 in the room and European and American accents highlight the global nature of the student body at LBS. Of the five finalists presenting none of the students are British.

Many of the presentations get bogged down in unnecessary detail, with the judges wanting metrics of how the businesses will perform over the next 10 years, such as revenue, growth, or EBIT.

“We want to know what the competitive advantage of the business is,” Guiness says.

Depending on the stock the general feedback was that more useful information was needed in the presentations – whether it be context around the management and competitive advantage, the wider industry and its volatility, or whether the market was building in any price corrections. For one stock, Seadrill, the judges said it was a “minefield of financial engineering and it was not clear what you’re buying”.

In this case the judges struggled to make a decision but in the end decided to take two half positions, in Cairn Energy and Prosegur – allocating £35,000 or 8 per cent of the fund across the two stocks – with one of the PhD students’ executing the trades the day after the competition.

The students congregated afterwards for free beer and networking. They were pleased with themselves. For those that participated there was a sense they were one step closer (with two more hours under their belts) to their dreams of becoming fund managers; and for those that watched, a sense of pride in their colleagues and their institution that what they had witnessed was part of the future of funds management.

 

 

The student finalists in the LBS Investment Management Club Summer Stockpicking Competition

  • Johannes Arnold’s chosen stock was Folli Follie
  • Joan Esteve Manasanach’s chosen stock was CVR
  • Jeff Smith’s chosen stock was Prosegur Compania Seguridad
  • Henrik Madsen’s chosen stock was Cairn Energy
  • Alex Karam’s chosen stock was Seadrill

 

 

LBS student investment fund performance

 

The UK Law Commission has delivered its final report on how the law of fiduciary duties applies to investment intermediaries and an evaluation of whether the law works in the interests of the ultimate beneficiaries. The project was commissioned by the Department for Business, Innovation and Skills (BIS) and the Department for Work and Pensions (DWP) in March 2013.

The Law Commission’s initial consultation paper was published in October 2013 and received responses from 96 consultees, and it has now delivered its final report

The report’s terms of reference covered five things:

(1) Investigate how fiduciary duties currently apply to investment

intermediaries and those who provide advice and services to them.

(2) Clarify how far those who invest on behalf of others may take account of factors such as social and environmental impact and ethical standards.

(3) Consult relevant stakeholders.

(4) Evaluate whether fiduciary duties (as established in law or as applied in practice) are conducive to investment strategies in the best interests of the ultimate beneficiaries. We are asked to carry out this evaluation against a list of factors. In particular, do they reflect an appropriate understanding of beneficiaries’ best interests, are they sufficiently certain, and do they encourage long-term investment strategies?

(5) Identify areas where changes are needed.

 

The report can be accessed here

 

A decade since the formation of the Rotman International Centre for Pension Management is a good time to review the organisation’s raison d’etre. Amanda White spoke to ICPM chair, Barbara Zvan, chief investment risk officer of Ontario Teachers’ Pension Plan, and the outgoing and incoming executive directors, Keith Ambachtsheer and Rob Bauer.

 

“There is not a day that goes by there isn’t a pension story in the press. There is a lot of change in the pension community,” says Barbara Zvan, chief investment risk officer of Ontario Teachers’ Pension Plan “This is an analogy for us too, there is a whole bunch of change at ICPM,” she says of the organisation she chairs.

The International Centre for Pension Management at the Rotman School, University of Toronto, is a research-partner driven organisation, with 39 organisations from 12 countries now signed up.

It was formed 10 years ago as part of the Rotman School of Management of the University of Toronto under the leadership of Keith Ambachtsheer, with the idea the pension fund research partners would fund it and drive the research and discussion-forum agenda. Pension design and management remain the dual focus.

A decade later the organisation has funded 35 research projects, delivered 20 discussion forums in nine different locations, published 11 issues of the International Journal of Pension Management made up of 92 articles. And the Rotman-ICPM Board Effectiveness Program will be held for the fifth time this coming December.

Ambachtsheer will step down as executive director this year with Rob Bauer, professor of institutional investment at Maastricht University School of Business and Economics, taking the helm.

“In the past 10 years we have achieved a lot, including regularly bringing a big group of people from international organisations together. We’ve built a community,” Bauer says.

He sees one of the challenges as keeping the entire group engaged with the dual pension design and investment elements.

“We talk about pensions and investments in an integrated way, and our agendas are based on feedback from our members.”

Bauer was an ICPM board member representing the giant Dutch pension fund ABP in 2004 when the organisation was borne, and has been part of ICPM since the beginning.

Bauer and Ambachtsheer have had a close working relationship since, sharing common ideals and strategic thinking with complementary skills and competencies.

Zvan was appointed chair this year, replacing Don Raymond, who was chief investment strategist of CPPIB and chair since 2008, but left the fund to join a service provider.

One of the defining characteristics of the ICPM forums is its strict “Door Policy”, keeping the group closed from the distractions of fund managers and other service providers. It’s for and of the asset owner.

Zvan is joined in leading the board by co-chair Tim Jones, chief executive of NEST in the UK.

“The coalition of 39 research partners representing the most influential pension funds in the world affords us the opportunity to foster meaningful dialogue and to cultivate innovative thinking from some of the greatest minds in the industry. These interactions allow us to strengthen and promote best practices in our industry,” Zvan says in the annual report.

Bauer, Zvan and the entire board are taking the opportunity presented by new leadership to look at the offerings of ICPM and will conduct a strategic review over the next six months.

While there is no doubt the four tools and the mission of fostering effective pension design and management will remain core, how they are delivered will be re-examined, with member input of course.

Ambachtsheer is proud of ICPM’s many achievements over the past decade. He points to the funding of a number of past and ongoing research projects that focus on the relationship between the performance of pension organisations and such factors as scale, structure, operating costs and governance quality.

In addition, preferred access by ICPM-funded researchers to the extensive CEM database has been helpful in this work.

“As a result of this research, large funds are understanding the business they are in,” he says. “Good governance and insourcing enhances performance and reduces costs.”

For Ambachtsheer the dream is not over. He will continue as emeritus director of ICPM leading the Board Effectiveness Program and editing the journal.

And he’s not one to think small. His ideas of what the next phase of ICPM might be include whether it has a role in collaboration.

“When I think about where do we go from here I see that the long-horizon topic is something covered by many organisations – PRI, ICGN, OECD, CFA,” he says. “Do we let a thousand flowers bloom and see where it goes, or is there an information exchange possibility?”

The future, as always, remains to be seen.

 

 

Two finance professors at the London School of Economics have introduced a new way to measure the amount of risk arbitrage in markets.

Their novel measure, dubbed “comomentum”, exploits time variation in how momentum stocks excessively “comove” together to reveal how crowded the classic price momentum trading strategy is at any point in time.

They show that comomentum predicts when momentum trading transitions from a profitable, under-reaction strategy to a risky, crash-prone bet. This new work was one of the presentations at the London School of Economics investor roundtable in June, hosted by conexust1f.flywheelstaging.com.

The professors claim the practical implications of their insights are enormous, allowing individual managers to allocate their capital more profitably as well as collectively ensuring a less risky, more efficient global financial system.

Christopher Polk, professor of finance and director of the financial markets group at the London School of Economics, is one of the professors who have coined the new word – comomentum.

And as he explains it is a measure of how momentum stocks comove together, revealing those times when momentum strategies become unprofitable and crash-prone.

“Professional investors, or arbitrageurs, play a key role in finance,” Polk says. “In our standard models, they work to ensure that markets are efficient. While this is often a realistic portrayal, a more nuanced view recognises that arbitrageurs’ positions can become crowded; with too much trading destabilising prices.”

Polk emphasises that it is essential these dynamics are understood but that it is extremely difficult to measure the amount of arbitrage activity at any given time.

“Direct measures of arbitrage capital employed are entirely inadequate. They estimate only a portion of the inputs to the investment process, for a subset of arbitrageurs,” he argues.

“Our insight is to examine the outcome of that process. In particular, we measure the correlated price impact that occurs when arbitrageurs collectively invest in similar strategies. “Our approach can then be used to test whether arbitrage activity can push prices away from fundamental value.”

Polk and his LSE coauthor Dong Lou use their novel measure to study momentum trading. Polk points out that momentum’s positive-feedback nature makes it especially susceptible to crowding.

“Prices are going up because arbitrageurs are buying, which in turn makes the positions even more attractive to them,” he says.

Polk first shows that comomentum is correlated with variables linked to the degree of momentum trading. Then he uses this new measure to forecast key properties of momentum trading strategies.

“As comomentum increases, momentum predictably transitions from being a profitable strategy exploiting under-reaction to a volatile and crash-prone overreaction bet,” he told delegates at the London School of Economics roundtable.

Indeed, Polk reveals that the comomentum measure increased dramatically prior to the recent momentum crash in March 2014.

“The problem is that momentum trading doesn’t have a fundamental anchor to tell arbitrageurs when to stop trading.” Polk states. “Contrast that with a value bet. Value investors naturally reduce their value bets when the value spread narrows.”

“We provide a new way of measuring arbitrage activity that exploits the output of the arbitrage process, namely excess return comovement. Our results suggest that ‘smart money’ can be destabilising, when positive-feedback trading becomes crowded,” he says.

“The practical implications of our insights for active investment strategies are enormous. Our new measure provides a tool that not only allows individual managers to allocate their capital more profitably but also collectively ensures a less risky, more efficient global financial system.”

 

The academic paper can be accessed here Comomentum – Inferring arbirtage activity from return correlations – Christopher Polk